Credit Connect

No one involved in credit management, collections and recoveries will have missed the news pieces written over the last couple of weeks in the FT, Telegraph and even Daily Mail, about the debt purchase market.

This seems to have been triggered by Bybrook Capital (a hedge fund), whose presentation in October close to Cabot’s (now-shelved) IPO and some devaluation in Arrow Global’s shares has created a flurry of activity.

In my view, discussion about the place of debt purchase, the major European debt purchasers and the strength of these businesses is nothing new. Furthermore, the cynic might say that Bybrook, a hedge fund with a reported short position on Arrow, expressing some of their views is not wholly surprising.

However, putting this to one side and taking a bigger picture view, this discussion gives us another prompt to think about the place of debt sale in a collections and recoveries strategy.

On ‘debt collectors’…

One thing that annoys me about these articles is the consistent use of ‘debt collectors’. To my mind the companies being discussed are (allowing for some diversification/variation) basically debt purchasers – and I will refer to them as such here. I could be accused of being pedantic, but debt collection and recoveries is an activity that is conducted by all that provide credit as part of their business, and debt sale is one of many options available – just as are using in-house functions or other specialist businesses like debt collection agencies, trace, legal, enforcement etc. that are doing debt collection too.

What is a debt purchaser?

For those not familiar with debt purchasers, fundamentally they are businesses that buy debt from creditors at a very substantial discount against face value. They are able to collect the debt over an extended period of time, longer than the creditor can afford, making a profit once collection costs and time value of money are taken into account.

The debt purchase market in UK/Europe is dominated by several large firms, like Cabot, PRA, Arrow, Hoist, Intrum and Lowell. These are often owned by American or Scandinavian investors.

In addition to these ‘tier one’ purchasers there are also smaller, niche or secondary purchasers. Outside of collecting on purchased debt, many firms have been diversifying their business model and also perform collections work on a non-purchase basis, both 1stparty or 3rd party on headcount or commission basis, although there are at least two schools of thought on whether this is a healthy coexistence.

The reasons for debt sale, from a creditor point of view, can be varied including balance sheet management, operational capacity constraints, desire to exit a market, intent to generate some short-term cash or unwillingness/inability to invest in niche capabilities needed to collect/recover.

From the customer perspective there should be no difference in quality of treatment between a contact from a creditor, (1st or 3rd party) outsourcer or debt purchaser – although the name will change and strategy/approach may be different.

Historically debt sale used to be limited to aged debt, where internal activity had been exhausted.

Recently however this profile has changed, with earlier debt increasingly being sold, including paying accounts, such as those on repayment plans for example (and this trend could accelerate further once IFRS9 is implemented in January 2018).

So, what have the recent conversations meant?

Whilst recent discussions have been interesting and clearly of great importance to the debt purchasers themselves and their shareholders, does it mean much for creditors?

In the short term probably not. Debt already sold will be managed in line with the agreements already made, so provided they are good and there are no ‘shocks’ caused by this discussion it should be business as usual. If this piece makes you think ‘I should probably check the conditions of a past sale,’ then that would be a good plan, as would putting in an action/contingency plan as a result if you think you need it.

In the medium-long term however there may well be some change as a result. Prices paid for debt and the investment in collecting it are subject to market conditions including cost of finance, cost to collect, competition and shareholder expectations on returns. Some of these variables have clearly changed and will therefore change the market.

What do I need to do?

If you are a provider of credit, this may be your first thought.

If you already have strong credit management, strategy and debt collection capabilities then you ought to be able to cope. Many organisations have been/are investing heavily in such functions so ought to be able to adjust accordingly.

However, if you have never considered a debt sale, or still operate on a fairly rudimentary level, this could be an area of opportunity.

Portfolio modelling, analytics, data, strategy, operations, outsourcing, management, control and auditing are all important in any sale process and critical in a changing market. It should be an area of focus to review and improve as a result.

So, what will the future role of debt purchase be?

Our view is that debt sale will still have a similar place within credit management and debt collections/recoveries – it remains a tool within ‘the kitbag’.

However, some things will change. As good practice, use of debt purchase should be part of an overall strategy with appropriate conduct oversight within a target operating model, consistent with business strategy.

The position may shift but this ought to be manageable with strong policy, strategy, tools and processes in place.